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For about four months in 1961, I was a 17-year-old American Field Service exchange student in a Japanese high school. I've been a self-styled foremost authority on that country ever since. Forty years after my experience, Japan may offer a glimpse into our own economy's future. To the extent that investing overseas offers diversification, Japan may help us make informed decisions about asset allocation outside of the United States. For 11 years leading up to 2001, the Japanese stock market was basically stagnant. Their stock market's previous expansion tracks almost exactly like ours, except the Nikkei's bull market occurred during the 1980s and ours happened 10 years later. Looking at the two lines super-imposed (but understanding the 10-year spread of time) reveals an uncanny resemblance. After 10 years of disappointment, Japanese markets generated some momentum back in 1999, but they have since dropped back in response to events in the rest of the world's economies. Could Japan be poised for a comeback, and will it happen in an explosive burst that has characterized this country's past performance? In 1999, Japanese small-company stocks were up more than 200 percent and have since given back only 50 percent. This works out to a two-year gain of 50 percent if you do the math. Hint: If a stock gains 100 percent (doubles in value), and then loses 50 percent in value, you are back at the original price. However, as Warren Buffett says, stock prices rarely depict the true value of the companies they represent. Instead, they are usually much higher or much lower depending on the pendulum swing of public opinion. The professional term for this is "market inefficiency." A tiny group of gifted money managers have capitalized on this phenomenon to make a lot of money for themselves and their clients. Unfortunately, we never know until after the fact which money managers are, in fact, so gifted. There is a 95 percent chance that, in any given time period, we chose one of the other guys. Returning to Japan, there's yet another new premier, who once again is embarking on a plan to resuscitate the economy. Reducing the interest rate to less than 1 percent hasn't done anything. The system is deadlocked. A necessary corrective step is to allow insolvent banks to go bankrupt. A fundamental reason why Japan has prolonged its agony is that the society treats bankruptcy much differently than we do here. In America there is a tolerance for failure, and lenders fix a rate of interest that takes into consideration the fact that some loans will never be paid back. Here, we have a tolerance for our losers. Take John Chambers, for instance, who presided over the demise of Wang Computers before going on to triumph at the helm of Cisco. In Japan, he probably would not have had that second chance. In most Asian countries, to preside over or to participate in a business failure amounts to a career-ending injury. Protecting against the downside is much more important than anticipating the euphoria of a dramatic upside. This is why the decision-making process involves large groups rather than single gunslinger CEOs: "If we're going to go down, we're all going down together." This different cultural imperative is what makes it so difficult for Japan to just digest its problems and move on. Instead, there have been giant public works programs that are designed to prop up failing companies at the taxpayers' expense. The election of the latest premier, a loose cannon within his own party, is a message from the electorate that they are ready for change-however painful it may become. Meanwhile, there are companies in Japan that continue to make money. The financial trade press talks about the extent to which money managers are increasing their concentration in Japanese stocks. The expectation that the economy will strengthen and that problems will sort themselves out is all we may really need to trigger some dramatic rise in the market. We learned back in the '80s that when Japan is good, it's very, very good. Those millions of team players who started every workday with group calisthenics brought the American automobile industry to its knees. These people are still productive and dedicated. It's the country's dysfunctional financial system that is failing. Another cloud over any recovery is the extent to which Japanese markets and financial information can be manipulated. My knowledge of this comes only from anecdotal evidence. For example, the mergers and acquisitions manager of one of this country's largest investment banks told me that he never feels comfortable with financial information on potential Japanese transactions. Too often, he has been presented with surprises after the fact. This, however, is considered true in almost all markets outside the United States. Whether it's true in Japan, or just xenophobia on our part, is subject to debate. In any case, we should not let it stand in the way of what might be an excellent alternative investment and a good effort to further diversify. All this points to the role of international funds in our retirement investment mix. It may take several years for the U.S. stock market to sort out the turbulence of the last three years. Our stocks are still overpriced by historical standards. Meanwhile, markets such as Japan's are undervalued when we consider that country's substantial companies who continue to make a lot of money. Keep in mind that, from 1992 through 1994, foreign index funds outperformed the S&P 500 by approximately 30 percent. A typical foreign fund today has about 20 percent of its assets invested in Japan, so I chose this country to illustrate the point. If we enjoy the psychological benefit of having at least something in our retirement portfolio generating a dramatic gain in any given year, we might find more immediate (or at least sooner) gratification with a foreign investment fund. A closing thought: There are about 20 Mayan dialects spoken in different parts of Central America. Three of those dialects allow their speakers to step off the plane in Tokyo and be understood by the Japanese. It's a small world after all. As a proxy for foreign investment, Japan is worthy of consideration in a well-diversified retirement portfolio.
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